Relative Strength Index (RSI)?
What is the Relative Strength Index (RSI)?
The Relative Strength Index, commonly referred to as RSI, is a momentum oscillator invented by J. Welles Wilder. It measures the speed and change of price movements. The RSI is a popular technical indicator used by traders to identify potential trend reversals and assess the strength of a trend.
To calculate the RSI, we use this formula:RSI = 100 - (100 / (1 + (Average Gain / Average Loss)))
It considers a certain period’s average gain and average loss based on closing prices. Typically, a 14-day period is used.
RSI values range on a scale from 0 to 100, helping us determine overbought or oversold conditions. When the RSI exceeds 70, it may indicate an overbought market, suggesting a possible trend reversal. An RSI below 30 might signal an oversold market, which could anticipate an upcoming trend change.
We also look for divergences between RSI and price action as a hint for potential reversals. If the price hits a new high but the RSI does not, it’s called a bearish divergence, suggesting buyers are losing momentum. Conversely, a bullish divergence occurs when the price touches a new low while RSI does not, indicating selling pressure is waning.
Here’s a simplified RSI scale interpretation:
RSI Value | Market Condition |
---|---|
Above 70 | Potentially Overbought |
Below 30 | Potentially Oversold |
By understanding the RSI, we can make informed decisions on market entry and exit points, improving our investment strategy.